By Irina Slav
U.S. oil prices slumped into negative territory less than a month ago as storage space fills up fast. And yet it appears that some producers are ready to start drilling again the moment WTI reaches a certain level. Interestingly enough, this level is below most companies’ breakeven price. Bloomberg reported this week that companies, including Parsley Energy, Centennial Resource Development, and Diamondback Energy, were ready to reverse the production cuts when prices rose to $24 (for Centennial) or $30 (for Parsley). It sounds counterintuitive when demand is still severely depressed and the inventory overhang is enormous. But some producers have little choice. They have a debt to repay.
Wood Mackenzie reported this week that oil drillers in the Lower 48 faced repayments of more than 50 percent of their principal debt by 2025. To repay this debt, they need cash–cash that is hard to come by right now.
Banks are not helping, either. They are squeezing credit availability to the industry and even preparing to seize some assets oil companies used as collateral for a combined $200 billion in debt.
Meanwhile, the broader context is not particularly optimistic either. Despite a substantial improvement in WTI prices over the last two weeks, volatility remains high, and market experts are warning against premature bullishness.
“Front-month WTI oil futures will continue to be volatile until the storage problem is resolved and traders are confident that if their position expires they will be able to store oil at a reasonable price,” says DailyFX.com market economist Nicholas Cawley. “With global economic activity unlikely to pick-up in the foreseeable future, demand for oil will remain low and the current imbalance against excessive supply will continue to cap any rally in WTI oil futures.”
And yet demand for oil is beginning to show the first tentative signs of improvement as countries in Asia and Europe, and many U.S. states start to relax their lockdowns. Bloomberg’s Javier Blas reported earlier this week that data from around the world was suggesting a pick-up in fuel consumption, which in turn hinted that the worst might be over.
However, it’s worth treating these early signs of demand improvement cautiously. For one thing, there are still way too many unknowns around the coronavirus for comfort. Some are warning about a second and even a third wave of infections. Most experts argue that the virus is something the world will need to learn to live with until a vaccine is developed. All this points to a new normal that will inevitably involve less travel and, as a consequence, persistently lower demand for fuels.
Can shale drillers survive this extended period of depressed demand?
It depends on how long this period will continue and how quickly prices will react to the tentative improvement in oil demand. For now, they are responding swiftly: WTI posted a five-day uninterrupted rally as of yesterday. Yet the downside risk remains quite pronounced because of the storage space problem.
The great advantage of shale drillers versus conventional field operators is that shale wells can be put into production much more quickly. Parsley Energy, for instance, told Bloomberg that it could ramp up production at its wells in a matter of a week or two. That’s compared to months for conventional wells that have been shut in because of unfavorable prices.
One significant problem is that the moment the oil market gets wind of shale drillers ramping up, prices will slide as fast as they rose because of the fundamentals situation. This places those shale drillers who are waiting for WTI to increase by another few dollars to start drilling again in an awkward position. Any ramp-up in production is likely to be short-lived if it is premature. But with debt maturities looming large on the horizon, it may be challenging to wait for a better time to restart shuttered production.